Binomial Interest Rate Trees

[ChadWOB]

Hi David,

In your opinion, what has been the 'testability' of this topic on previous exams for Lev2? I don't remember seeing many questions on this for Lev1 related to options, was just wondering if it is a crucial to know this in detail for Lev2 in relation to bond valuation?

Thanks,
Chad

 

[David Harper CFA FRM]

Hi Chad,

It's just my experienced guess, but I view Tuckman Chapter 9 (I'm assuming your question is limited to Tuckman Ch 9) as one of the least "efficient" assignments in P2: several AIMs that, to my knowledge, have not been tested. (Ch 7 on key rates is in a similar bucket, pun intended: many AIMs yet where are the questions?? frustrating). So far, GARP hasn't queried deeply on either of these. Much more likely are superficial elements, for example: probability of an up (p), magnitude of up/down (u, d), maybe figuring out the value of a missing node. These are mostly likely. (It's too time consuming to do a full on tree valuation, in practical terms). If time is short, I'd tend to agree with your suggestion that this chapter (and i'd include Key rates) don't deserve same priority as other selections. Just my thought, I'd love to see the efficiency of this improved, hopefully it will be possible in 2013 with the new 3rd edition (yippee!) http://forum.bionicturtle.com/threa...new-3rd-edition-10-years-since-the-last.5655/

but don't get me wrong, i realize timing is a constraint, but binomial trees are like other exercises (swap valuation, CDS valuation): while the whole enchillada won't/can't be tested, you invariably get exposed to "building blocks" that are/can be tested, so it's never a waste of time....obviously, i still don't know how to answer this sort of question

 

[ChadWOB]

Great, thanks for the insight.